Question

Suppose that every time a fund manager trades stock, transaction costs such as commissions and bid–ask spreads amount to 1.4% of the value of the trade. If the portfolio turnover rate is 50%, by how much is the total return of the portfolio reduced by trading costs? (Round your answer to 1 decimal place.)

Fall in returns %

Answer 1

The total return of the portfolio is reduced by 0.7% due to trading costs, which are 1.4% of the trade value with a 50% portfolio turnover rate.

Step-by-step explanation:

The question asks about the impact of trading costs on the return of a portfolio. Specifically, it involves a scenario where a fund manager experiences trading costs amounting to 1.4% of the trade value with a portfolio turnover rate of 50%. To calculate the reduction in the portfolio's total return due to trading costs, we can use the following formula:

Total Return Reduction = Trading Costs * Portfolio Turnover Rate

Given that the trading costs are 1.4% and the portfolio turnover rate is 50%, the reduction in total return is calculated as:

0.014 * 0.50 = 0.007 (or 0.7% when expressed as a percentage)

Therefore, trading costs reduce the total return of the portfolio by 0.7%, rounded to one decimal place.